Legal Aspects of Opening a Restaurant There … Research Paper

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Legal Aspects of Opening a Restaurant

There are four primary business structures an entrepreneur can employ when opening a restaurant: a sole proprietorship, a partnership, a corporation and a limited liability company (LLC). Several variables are worth careful consideration when deciding the appropriate structure for a business, including the tax implications, the relationship and goals among owners in an entity, and the extent of capital liability. Moreover, the competitive nature of the restaurant industry places a high priority on ensuring that owners have structured their entity in the best possible way to take advantage of the different benefits associated with each type of structure. Ultimately, long-term success or failure can hinge on the entity's structure.

In the following paper, the benefits and disadvantages of each type of business structure will be explored in the context of the restaurant industry. Additionally, the tax implications for each structure on the participants will be examined, with a careful eye toward the long-term consequences of each. However, it will be revealed here that the highest priority in such a highly competitive and failure-ridden industry is the nature of the co-participants and their relative passion for success. In most cases, a healthy and vibrant passion for the hospitality industry is essential and must be demonstrated by all participants over time. Ultimately, this paper will demonstrate the importance of not merely having the appropriate business structure for tax and liability purposes, but also to meet the vision and goals of the entity.

This is a key element of success in this field. The restaurant industry is renowned for providing opportunities that are risky and rife with pitfalls, and many restaurants fail within one year of opening. A recent study suggests that restaurants have only a 20 per cent chance of surviving for two years

. Among the most common reasons are shortfalls in capital, improper management, poor quality of food and service, misperception of market base and over-saturation of the market

. Furthermore, anecdotes persist regarding restaurants that have demonstrated proficiency in each of these areas, hired an experienced staff and poured capital into the business, only to find imminent failure. On the other hand, many successful restaurants have persevered in spite of apparent deficiencies based on location, market trends, or just sheer good fortune. The restaurant industry is therefore known for meting out success and failure sometimes arbitrary and capricious ways. Some of the most successful restaurant chains and operators have a string of failures in their past, and many in the industry feel that exceptional service is necessary for a restaurant to find success

On the other hand, the restaurant industry surpassed $450 million in revenue in the U.S. In 2009, making it one of the most productive sectors in the country. Nearly 11 million people are employed in the hospitality sector, equivalent to just over 9 per cent of all employed Americans. Though this doesn't correlate to the high incidence of failures among new restaurants, all relevant statistics bear out the fact that American diners continue to have disposable income, in spite of the global economic crisis of 2008. There have also been many successful restaurants in recent years, across different types of cuisine and price points. The success stories also cross the various types of ownership structures, which we will discuss in this paper.

A brief examination of each entity type will ensue, including a demonstration of the merits and drawbacks of each in business. These aspects will then be applied to the restaurant industry, with a focus on the various types of restaurants (i.e. franchise venture, mom-and-pop diner, upscale dining, etc.). It will become clear that, while the decision regarding business structure is extremely important, in many cases there is no clear-cut correct answer. Therefore, the long-term vision and goals of the entity frequently are the most important variable in making this determination. Finally, we will conclude with an analysis of the future prognosis of the restaurant industry, and the basic framework and attributes of successful entrants, across business structures.

Sole Proprietorship

The most basic form of business ownership is the sole proprietorship

. The sole proprietorship is an unincorporated company that is solely owned and operated. It is the simplest to establish and run, requiring only the state and local licenses necessary in the relevant field and typically requiring no annual dues or maintenance fees. The tax structure of a sole proprietorship is similar to personal taxes, insofar as all profits and losses are reflected in personal financial statements. Therefore, the sole proprietor is responsible for claiming and paying all tax accountability him or herself, just as is anyone who is self-employed. The sole proprietor has no indemnity for losses and assumes all of the risk associated with the business format. Therefore, any existing creditors can demand that personal assets cover business-related losses. Also, the limits on equity are completely related the equity of the proprietor. In other words, the start-up and operating costs, which can be high in the restaurant business, are a product of the financial viability of the proprietor alone

Sole proprietorships are the oldest and most traditional form of ownership in the restaurant industry. They are most common in smaller mom-and-pop, family-owned restaurants, and have had a great deal of success. They offer the benefit of complete control of operations, and power over day-to-day business decisions. In a business in which success is frequently driven by passion for the business and for hospitality, sole proprietorships allow for personal drive to be a primary determinant regarding financial success or failure. They are preferable for eliminating the need to work with other individuals and allow a solitary person to execute a vision on a daily basis without the need to consult with someone else. Therefore, the benefits are mostly psychic and personal, though these can be substantial enough to see the business through to success.

There are additional economic benefits to sole proprietorships, including the certainty that dividends will not be taxed both as personal and business-related income, also known as double taxation

. In a sole proprietorship, the owner benefits from all of the profits and suffers all of the losses. Profits are taxed as personal income and business expenses are deductible.

In a business where the doors open nearly everyday, this means the sole proprietor signs every check to pay for the continual purchase of the fresh ingredients necessary to serve food, drawing on the funds from his or her own bank account. It also means that every dollar in profit margin -- represented by bodies in chairs and plates in the kitchen window -- finds its way to the same pool of resources from which the checks are drawn. A key element of choosing this solitary model of ownership is the tolerance the individual has for bearing every penny of economic pressure. It is therefore worth noting that the sole proprietorship is increasingly being passed over in favor of business structures that diffuse risk and which offer limited forms of liability.

Partnership

General partnerships are unincorporated business structures in which two or more entrepreneurs enter into business for the purpose of generating profit margins. Partnerships do not have the advantage of limited liability protection. However, they spread the risk across all owners involved in the entity, diffusing the burden that any individual owner would assume. The joint accountability refers also to the personal assets of each partner. Additionally, each partner is accountable for profits, losses and deductions to be reported on personal income taxes. Therefore, the partnership itself is not taxable; it is merely a tax-reporting entity.

Limited partnerships are possible in which general partners and limited partners each provide capital to the entity. This reduces the start-up costs associated with the entity. It also facilitates the combination of experience and management skills of a variety of entities and people, which can lead to better decision-making and more rationale choices over the long-term lifespan of the business. However, limited partners are typically not permitted to exert control or manage the business on a day-to-day basis. The liability of the partner is also limited, usually to the amount of his or her investment

. In other words, a limited partner cannot be hurt by the mismanagement, negligence or malpractice of other owners beyond the investment capital already contributed to the entity.

Effective partnerships require an uncommon confluence of economic and personal circumstances, and for this reason they are the least common of the entrepreneurial structures discussed here in the restaurant industry. It can be difficult to find appropriate partners for the scope of the project, insofar as their qualifications are based on economic and personal factors. Not every business owner can accept the limited role associated with partnerships, and personality conflicts can arise. In the restaurant business, owners are typically passionate and single-minded, and many cases exist in which financially complimentary owners do not mesh philosophically. In partnership, an individual owner can make binding economic and operational decisions that affect the other owners. Also, the profits… [END OF PREVIEW]

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